Avoiding trouble in China

How to stay on the right side of international anti-bribery laws

July/August 2012

ByPeter Humphrey, CFE

In the last three decades, China has shown stunning economic and social progress. However, its super achievements have come at a cost — the dramatic resurgence of corruption and widespread fraud. Here are ways that multinational companies can keep out of trouble in China.

UTStarcom, a U.S.-listed firm with Chinese roots, paid US$7 million for hundreds of overseas trips by the personnel of Chinese state-owned enterprise (SOE) telecom firms for so-called "customer training." Actually, the trips were sightseeing jaunts to flashy tourist and gambling spots including Las Vegas, Hawaii and New York.

How does this kind of racket work? Executives of major SOEs typically demand "product inspection" trips financed by U.S. manufacturers with a budget of US$4,000 to US$6,500 per person for spending 14 days in the U.S., Europe or Australia.

A typical itinerary includes New York, Las Vegas, Los Angeles and Hawaii, or trips to Australian cities with a Thailand leg, or with Rome, Madrid and Copenhagen thrown in.

The parties discuss such provisions with the manufacturer's Chinese SOE distributor, but the official contract doesn't include the production inspection trips' budget, except perhaps for a vague mention of "buyer's rights to inspect goods."

"Visit fees," however, appear in a manufacturer's sales order for internal accounting. The manufacturer wires the funds in cash to a personal account or the overseas accounts of the distributors. Part is paid to domestic or foreign travel agents and part is paid in cash to the traveling SOE executives. Sometimes distributors wire funds to overseas accounts.

Money from more than one foreign manufacturer may sometimes be pooled into a slush fund to finance a combined touring delegation.

This is one of scores of new corruption cases resulting from China's changing cultural and economic climates.

I have spent most of the past 30 years or so in China — with the last 14 working in fraud and corruption investigations. When I look at the country today and think about the nation where I arrived in 1979 — a country driven by horse-carts and mired in deep poverty — it's impossible to ignore its stunning progress. Yet, China's super economic achievements have come at a cost — the dramatic resurgence of corruption and widespread fraud. This plague of corruption and bribery is challenging multinational companies who risk running afoul of international anti-bribery laws over malpractices in China.

First let's take a quick look at the economic and social environment that has spawned this corruption.

By certain benchmarks, China has now become the world's second-largest economy after the U.S. While much of the world was in a deep recession, China surged ahead, continuing to report stunning annual GDP growth rates around 10 percent. China's GDP in 2011 reached US$7.49 trillion, according to the National Bureau of Statistics of China. Foreign direct investment in China in 2011 reached US$117.7 billion, according to China's Ministry of Commerce.

Against China's amazing economic backdrop, the country has the world's largest population — 1.3 billion plus now and still growing. Half this population still lives off the land, with income levels much lower than the wealth of the coastal cities and the urban elites. One of the largest drivers of graft and fraud in China is this economic polarization of rich and poor and the pressure to make money by every imaginable shortcut. Let's look at a few illustrations of this wealth gap.

Despite China being the world's second largest economy, its per capita GDP is a mere fraction of America's. Mainland China's in 2011 was US$5,555, according to the National Bureau of Statistics of China compared with about US$48,387 in the U.S, according to the World Economic Outlook Database of the International Monetary Fund. We see data like China's retail sales growing 17.1 percent in 2011 while the rest of the world is in recession. But urban per capita disposable income in 2011 stood at a paltry annual level of US$3,461 according to the National Bureau of Statistics of China.

In the countryside, where half the population lives, rural per capita income in 2011 was just US$1,107 per year, according to the National Bureau of Statistics of China. We see lots of stories about Chinese millionaires, but the figures above mean that half the Chinese population lives on little more than $2 per day. The wealth gap is a major contributing factor to bribery in this country.